FAIR VALUE OF FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2016

NOTE 12 – FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair value is based on discounted cash flows or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. The accounting standard for disclosures about the fair value of financial instruments excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The Company has elected to record mortgage loans held-for-sale at fair value in order to eliminate the complexities and inherent difficulties of achieving hedge accounting and to better align reported results with the underlying economic changes in value of the loans and related hedge instruments. This election impacts the timing and recognition of origination fees and costs, as well as servicing value, which are now recognized in earnings at the time of origination. Interest income on mortgage loans held-for-sale is recorded on an accrual basis in the consolidated statement of earnings and comprehensive income under the heading “Interest income – interest and fees on loans”. The servicing value is included in the fair value of the interest rate lock commitments (“IRLCs”) with borrowers. The mark to market adjustments related to loans held-for-sale and the associated economic hedges are captured in mortgage banking activities. Net gains of $3.0 million and $2.6 million resulting from fair value changes of these mortgage loans were recorded in income during the three months ended March 31, 2016 and 2015, respectively. The amount does not reflect changes in fair values of related derivative instruments used to hedge exposure to market-related risks associated with these mortgage loans. The change in fair value of both mortgage loans held for sale and the related derivative instruments are recorded in “Mortgage banking activity” in the Consolidated Statements of Earnings and Comprehensive Income. The Company’s valuation of mortgage loans held for sale incorporates an assumption for credit risk; however, given the short-term period that the Company holds these loans, valuation adjustments attributable to instrument-specific credit risk is nominal.

The following table summarizes the difference between the fair value and the principal balance for mortgage loans held for sale measured at fair value as of March 31, 2016, December 31, 2015 and March 31, 2015:

	March 31, 2016		December 31, 2015		March 31, 2015
	(Dollars in Thousands)
Aggregate Fair Value of Mortgage Loans held for sale	$	97,439	$	111,182	$	73,796

Aggregate Unpaid Principal Balance	$	94,346	$	107,652	$	70,905

Past-due loans of 90 days or more	$	-	$	-	$	-

Nonaccrual loans	$	-	$	-	$	-

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans and OREO. Additionally, the Company is required to disclose, but not record, the fair value of other financial instruments.

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Cash and Due From Banks, Federal Funds Sold and Interest-Bearing Accounts: The carrying amount of cash and due from banks, federal funds sold and interest-bearing accounts approximates fair value.

Investment Securities Available for Sale: The fair value of securities available for sale is determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Level 2 securities include mortgage-backed securities issued by government-sponsored enterprises and municipal bonds. The Level 2 fair value pricing is provided by an independent third-party and is based upon similar securities in an active market. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain residual municipal securities and other less liquid securities.

Other Investments: FHLB stock is included in other investments at its original cost basis. It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Mortgage Loans Held for Sale: The Company records mortgage loans held for sale at fair value. The fair value of mortgage loans held for sale is determined on outstanding commitments from third-party investors in the secondary markets and is classified within Level 2 of the valuation hierarchy.

Loans: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable. A loan is determined to be impaired if the Company believes it is probable that all principal and interest amounts due according to the terms of the note will not be collected as scheduled. The fair value of impaired loans is determined in accordance with ASC 310-10, Accounting by Creditors for Impairment of a Loan, and generally results in a specific reserve established through a charge to the provision for loan losses. Losses on impaired loans are charged to the allowance when management believes the uncollectability of a loan is confirmed. Management has determined that the majority of impaired loans are Level 3 assets due to the extensive use of market appraisals.

Other Real Estate Owned: The fair value of other real estate owned (“OREO”) is determined using certified appraisals that value the property at its highest and best uses by applying traditional valuation methods common to the industry. The Company does not hold any OREO for profit purposes and all other real estate is actively marketed for sale. In most cases, management has determined that additional write-downs are required beyond what is calculable from the appraisal to carry the property at levels that would attract buyers. Because this additional write-down is not based on observable inputs, management has determined that other real estate owned should be classified as Level 3.

Covered Other Real Estate Owned: Covered other real estate owned includes other real estate owned on which the majority of losses would be covered by loss-sharing agreements with the FDIC. Management initially valued these assets at fair value using mostly unobservable inputs and, as such, has classified these assets as Level 3.

Intangible Assets and Goodwill: Intangible assets consist of core deposit premiums acquired in connection with business combinations and are based on the established value of acquired customer deposits. The core deposit premium is initially recognized based on a valuation performed as of the consummation date and is amortized over an estimated useful life of three to ten years. Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill and other intangible assets deemed to have an indefinite useful life are not amortized but instead are subject to an annual review for impairment.

FDIC Loss-Share Receivable: Because the FDIC will reimburse the Company for certain acquired loans should the Company experience a loss, an indemnification asset is recorded at fair value at the acquisition date. The indemnification asset is recognized at the same time as the indemnified loans, and measured on the same basis, subject to collectability or contractual limitations. The shared loss agreements on the acquisition date reflect the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflects counterparty credit risk and other uncertainties. The shared loss agreements continue to be measured on the same basis as the related indemnified loans, and the loss-share receivable is impacted by changes in estimated cash flows associated with these loans.

Accrued Interest Receivable/Payable: The carrying amount of accrued interest receivable and accrued interest payable approximates fair value.

Cash Value of Bank Owned Life Insurance: The carrying value of cash value of bank owned life insurance approximates fair value.

Deposits: The carrying amount of demand deposits, savings deposits and variable-rate certificates of deposit approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently offered for certificates with similar maturities.

Securities Sold under Agreements to Repurchase and Other Borrowings: The carrying amount of variable rate borrowings and securities sold under repurchase agreements approximates fair value and are classified as Level 1. The fair value of fixed rate other borrowings is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar borrowing arrangements and are classified as Level 2.

Subordinated Deferrable Interest Debentures: The fair value of the Company’s variable rate trust preferred securities is based primarily upon discounted cash flows using rates for securities with similar terms and remaining maturities and are classified as Level 2.

Off-Balance-Sheet Instruments: Because commitments to extend credit and standby letters of credit are typically made using variable rates and have short maturities, the carrying value and fair value are immaterial for disclosure.

Derivatives: The Company has entered into derivative financial instruments to manage interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the derivatives. This analysis reflects the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair value of the derivatives is determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates (forward curves derived from observable market interest rate curves).

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting any applicable credit enhancements such as collateral postings, thresholds, mutual puts and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself or the counterparty. However, as of March 31, 2016, December 31, 2015 and March 31, 2015, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuation in its entirety is classified in Level 2 of the fair value hierarchy.

The following table presents the fair value measurements of assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of March 31, 2016, December 31, 2015 and March 31, 2015 (dollars in thousands):

	Fair Value Measurements on a Recurring Basis As of March 31, 2016
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U.S. government agencies	$	7,628	$	-	$	7,628	$	-
State, county and municipal securities		157,533		-		157,533		-
Corporate debt securities		8,522		-		7,022		1,500
Mortgage-backed securities		663,420		-		663,420		-
Mortgage loans held for sale		97,439		-		97,439		-
Mortgage banking derivative instruments		4,234		-		4,234		-

Total recurring assets at fair value	$	938,763	$	-	$	937,263	$	1,500

Derivative financial instruments	$	2,281	$	-	$	2,281	$	-
Mortgage banking derivative instruments		592		-		592		-
Total recurring liabilities at fair value	$	2,873	$	-	$	2,873	$	-

	Fair Value Measurements on a Recurring Basis As of December 31, 2015
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U.S. government agencies	$	14,890	$	-	$	14,890	$	-
State, county and municipal securities		161,316		-		161,316		-
Corporate debt securities		6,017		-		3,019		2,998
Mortgage-backed securities		600,962		-		600,962		-
Mortgage loans held for sale		111,182		-		111,182		-
Mortgage banking derivative instruments		2,687		-		2,687		-

Total recurring assets at fair value	$	897,054	$	-	$	894,056	$	2,998

Derivative financial instruments	$	1,439	$	-	$	1,439	$	-
Mortgage banking derivative instruments		137		-		137		-
Total recurring liabilities at fair value	$	1,576	$	-	$	1,576	$	-

	Fair Value Measurements on a Recurring Basis As of March 31, 2015
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

U.S. government agencies	$	14,984	$	-	$	14,984	$	-
State, county and municipal securities		159,064		-		159,064		-
Corporate debt securities		10,935		-		8,435		2,500
Mortgage-backed securities		425,347		-		425,347		-
Mortgage loans held for sale		73,796		-		73,796		-
Mortgage banking derivative instruments		4,006		-		4,006		-

Total recurring assets at fair value	$	688,132	$	-	$	685,632	$	2,500

Derivative financial instruments	$	1,805	$	-	$	1,805	$	-
Mortgage banking derivative instruments		548		-		548		-
Total recurring liabilities at fair value	$	2,353	$	-	$	2,353	$	-

The following table presents the fair value measurements of assets measured at fair value on a non-recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy as of March 31, 2016, December 31, 2015 and March 31, 2015 (dollars in thousands):

	Fair Value Measurements on a Nonrecurring Basis As of March 31, 2016
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans carried at fair value	$	25,831	$	-	$	-	$	25,831
Other real estate owned		1,857		-		-		1,857
Purchased, non-covered other real estate owned		15,048		-		-		15,048
Covered other real estate owned		3,764		-		-		3,764
Total nonrecurring assets at fair value	$	46,500	$	-	$	-	$	46,500

	Fair Value Measurements on a Nonrecurring Basis As of December 31, 2015
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans carried at fair value	$	27,069	$	-	$	-	$	27,069
Other real estate owned		10,456		-		-		10,456
Purchased, non-covered other real estate owned		14,333		-		-		14,333
Covered other real estate owned		5,011		-		-		5,011
Total nonrecurring assets at fair value	$	56,869	$	-	$	-	$	56,869

	Fair Value Measurements on a Nonrecurring Basis As of March 31, 2015
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans carried at fair value	$	28,867	$	-	$	-	$	28,867
Purchased, non-covered other real estate owned		13,818		-		-		13,818
Covered other real estate owned		16,089		-		-		16,089
Total nonrecurring assets at fair value	$	58,774	$	-	$	-	$	58,774

The inputs used to determine estimated fair value of impaired loans and covered loans include market conditions, loan terms, underlying collateral characteristics and discount rates. The inputs used to determine fair value of other real estate owned and covered other real estate owned include market conditions, estimated marketing period or holding period, underlying collateral characteristics and discount rates.

For the three months ended March 31, 2016, the year ended December 31, 2015 and the three months ended March 31, 2015, there was not a change in the methods and significant assumptions used to estimate fair value.

The following table shows significant unobservable inputs used in the fair value measurement of Level 3 assets and liabilities:

	Fair Value		Valuation Technique	Unobservable Inputs	Range of Discounts		Weighted Average Discount

As of March 31, 2016
Nonrecurring:
Impaired loans	$	25,830	Third-party appraisals and discounted cash flows	Collateral discounts and discount rates	0% - 100	%	27	%
Other real estate owned	$	1,857	Third-party appraisals, sales contracts, broker price opinions	Collateral discounts and estimated costs to sell	10% -90	%	13	%
Purchased non-covered real estate owned	$	15,048	Third-party appraisals	Collateral discounts and estimated costs to sell	10% -75	%	16	%
Covered real estate owned	$	3,764	Third-party appraisals	Collateral discounts and estimated costs to sell	15% - 59	%	17	%
Recurring:
Investment securities available for sale	$	1,500	Discounted par values	Credit quality of underlying issuer	0	%	0	%

As of December 31, 2015
Nonrecurring:
Impaired loans	$	27,069	Third-party appraisals and discounted cash flows	Collateral discounts and discount rates	0% - 100	%	29	%
Other real estate owned	$	10,456	Third-party appraisals, sales contracts, broker price opinions	Collateral discounts and estimated costs to sell	10% -90	%	13	%
Purchased non-covered real estate owned	$	14,333	Third-party appraisals	Collateral discounts and estimated costs to sell	10% -69	%	19	%
Covered real estate owned	$	5,011	Third-party appraisals	Collateral discounts and estimated costs to sell	0% - 74	%	12	%
Recurring:
Investment securities available for sale	$	2,998	Discounted par values	Credit quality of underlying issuer	0	%	0	%

As of March 31, 2015
Nonrecurring:
Impaired loans	$	28,867	Third-party appraisals and discounted cash flows	Collateral discounts and discount rates	0% - 70	%	24	%
Purchased non-covered real estate owned	$	13,818	Third-party appraisals	Collateral discounts and estimated costs to sell	10% -96	%	16	%
Covered real estate owned	$	16,089	Third-party appraisals	Collateral discounts and estimated costs to sell	10% - 70	%	9	%
Recurring:
Investment securities available for sale	$	2,500	Discounted par values	Credit quality of underlying issuer	0	%	0	%

The carrying amount and estimated fair value of the Company’s financial instruments, not shown elsewhere in these financial statements, were as follows:

			Fair Value Measurements at March 31, 2016 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in Thousands)
Financial assets:
Cash and due from banks	$	146,863	$	146,863	$	-	$	-	$	146,863
Federal funds sold and interest-bearing accounts		107,373		107,373		-		-		107,373
Loans, net		4,495,066		-		-		4,518,521		4,518,521
FDIC loss-share receivable		1,197		-		-		(5,114)		(5,114)
Accrued interest receivable		20,940		20,940		-		-		20,940

Financial liabilities:
Deposits	$	5,230,787	$	-	$	5,231,556	$	-	$	5,231,556
Securities sold under agreements to repurchase		43,741		43,741		-		-		43,741
Other borrowings		110,531		-		110,531		-		110,531
Accrued interest payable		1,119		1,119		-		-		1,119
Subordinated deferrable interest debentures		83,237		-		66,783		-		66,783

			Fair Value Measurements at December 31, 2015 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in Thousands)
Financial assets:
Cash and due from banks	$	118,518	$	118,518	$	-	$	-	$	118,518
Federal funds sold and interest-bearing accounts		272,045		272,045		-		-		272,045
Loans, net		3,971,974		-		-		3,982,606		3,982,606
FDIC loss-share receivable		6,301		-		-		(944)		(944)
Accrued interest receivable		21,274		21,274		-		-		21,274

Financial liabilities:
Deposits	$	4,879,290	$	-	$	4,880,294	$	-	$	4,880,294
Securities sold under agreements to repurchase		63,585		63,585		-		-		63,585
Other borrowings		39,000		-		39,000		-		39,000
Accrued interest payable		1,054		1,054		-		-		1,054
Subordinated deferrable interest debentures		69,874		-		52,785		-		52,785

			Fair Value Measurements at March 31, 2015 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in Thousands)
Financial assets:
Cash and due from banks	$	80,142	$	80,142	$	-	$	-	$	80,142
Federal funds sold and interest-bearing accounts		126,157		126,157		-		-		126,157
Loans, net		2,837,538		-		-		2,885,524		2,885,524
FDIC loss-share receivable		23,312		-		-		9,990		9,990
Accrued interest receivable		15,332		15,332		-		-		15,332

Financial liabilities:
Deposits	$	3,480,231	$	-	$	3,481,470	$	-	$	3,481,470
Securities sold under agreements to repurchase		55,520		55,520		-		-		55,520
Other borrowings		43,851		-		43,851		-		43,851
Accrued interest payable		1,177		1,177		-		-		1,177
Subordinated deferrable interest debentures		65,567		-		47,055		-		47,055

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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